THE CHAIRMAN 22 February 2016 To G20 Finance Ministers and Central Bank Governors The more difficult economic and financial conditions since the start of this year reflect in part downward revisions to the expected medium-term growth prospects of the world economy as a result of renewed appreciation of the structural challenges facing a number of advanced and emerging economies. More specifically in the financial sector they also reflect concerns that many banks have more to do to adjust their long-term business models to the lower growth/lower nominal interest rate environment and to the strengthened international regulatory framework. At the same time the greater resilience of the financial system resulting from that new regulatory framework will ensure that the financial system can better support jobs and growth in the short, medium and long term. Recent market turbulence really serves to underline the importance of continued progress in building resilient financial institutions and markets. The imperative now is to implement fully and consistently our past agreements. Authorities also need to remain vigilant to new risks and vulnerabilities and to ensure that markets are supported by robust financial infrastructure. In this manner the G20 can develop a diverse and open global financial system that can finance investment in the real economy throughout the economic cycle. The FSB’s priorities for 2016 to promote these objectives are: 1. Supporting the full and consistent implementation of post crisis reforms, while remaining ready to address any material unintended consequences. 2. Addressing new and emerging vulnerabilities in the financial system, including potential risks associated with market-based finance, asset management activities, conduct, correspondent banking and climate change. 3. Promoting robust financial infrastructure, working with CPMI and IOSCO to assess policies on central counterparty (CCP) resilience, recovery and resolvability, and recommending any necessary improvements. And we are supporting the objectives of the Chinese G20 Presidency by: 4. Drawing lessons, working with the IMF and the BIS, from the practical application of macroprudential policy frameworks and tools. 5. Assessing the systemic implications of financial technology innovations, and the systemic risks that may arise from operational disruptions. This letter sets out the FSB’s work programme to advance these and other goals during the Chinese G20 Presidency in 2016. 1. FULL AND CONSISTENT IMPLEMENTATION OF AGREED REFORMS The implementation of agreed reforms is essential for achieving financial stability and for building trust in an open global financial system. The FSB is supporting its members by reporting on implementation progress and assessing whether reforms have achieved their intended benefits. Our first annual report to G20 Leaders at Antalya on the implementation and effects of reforms noted that good progress has been made in banking reforms but that there is still some distance to go in other areas. We will continue to highlight to the G20 progress, shortcomings and challenges in implementation, as well as any unintended effects of reforms. The ongoing commitment of Ministers and Governors is needed to ensure that gaps and inconsistencies in implementation are corrected and, where any material unintended impacts have been identified, policies are adjusted. The FSB and the standard setting bodies are working to enhance the analysis of the effects of globally agreed reforms, including whether the reforms are working together as anticipated. This assessment will become more precise as more data is available and implementation advances. The FSB will organise a workshop in May to share experiences in analysing the effects of reforms, including the combined effects and interaction across sectors of related reforms. To prioritise and coordinate implementation monitoring efforts, we are working with other international bodies to develop a ‘heat map’ of resources required for future monitoring work. • By the Hangzhou Summit, the FSB will deliver to Leaders the second annual report on the implementation of the reforms and their effects, including a comprehensive review of whether there has been a reduction in market liquidity and, if so, its extent, drivers and likely persistence. 2. ADDRESSING EMERGING VULNERABILITIES Last year’s report on the implementation and effects of reforms identified three emerging challenges that we are now investigating further: • Developments affecting market liquidity and the role that reforms might have played; • Particular challenges facing emerging market and developing economies; and • Signs of fragmentation in the global financial system. We will report on these issues in this year’s annual report. Risks associated with market-based finance and asset management activities Since the crisis, net credit creation has been largely reliant on market-based debt finance, with emerging markets having tripled annual issuance of international bonds from 2008 to 2015. A sudden stop in provision of market-based finance, if not offset by bank credit, would lead to a pronounced reduction in the supply of credit to the real economy impacting jobs and growth. It would create particular challenges with capital outflows from emerging market and developing economies. The task of authorities is to ensure markets still function well under pressure and that financial systems are not undermined by market illiquidity or become fragmented. 2 Resilient and effective markets require adequate levels of realistically priced liquidity. As part of the FSB’s overall work to assess the extent, drivers and likely persistence of shifts in market liquidity, we have prioritised work to analyse structural vulnerabilities in asset management activities and to identify risks that may merit policy responses in four areas: (i) liquidity mismatch in funds; (ii) leverage within funds; (iii) operational risks in transferring investment mandates; and (iv) securities lending activities of asset managers and funds. An overoptimistic ‘liquidity illusion’ may have been reinforced by the growth of investment products offering redemptions at very short notice. Policies to reduce fire-sale risks in open-ended investment funds may also help to reduce some of the volatility in capital flows. We are analysing vulnerabilities associated with these asset management activities and expect to issue policy recommendations for public consultation before the Hangzhou Summit. Once the above activity-based work is completed, the FSB, jointly with IOSCO, will conduct further analysis and finalise the assessment methodology for asset management under the global systemically important financial institutions (G-SIFI) framework. This analysis will focus on any residual risks once measures to address these activities are taken into account. Under the G20 shadow banking roadmap, the FSB will also evaluate in 2016 the case for developing further policy recommendations to mitigate financial stability risks from shadow banking entities, based on the findings from its information-sharing exercise and peer review. • By the Hangzhou Summit, the FSB will publish a consultative document with its assessment of any structural vulnerabilities associated with asset management activities and policy recommendations to address them. • By your July meeting, the FSB will publish its peer review on implementation of the Framework for Oversight and Regulation of Shadow Banking. Misconduct risks The FSB will continue to work on reducing misconduct risk, including exchanging best practices on governance frameworks and potentially developing a supervisory toolkit or guidance; examining the effectiveness of post crisis reforms to compensation and whether disincentives to misconduct should be strengthened; and sharing national experiences on bank regulators’ enforcement powers. This work will take into account the work of standard-setting bodies, including IOSCO’s ongoing analysis of related issues in securities markets. IOSCO intends to publish by year-end a toolkit of measures to promote proper conduct by market participants, including individuals and firms, in professional markets. • By the Hangzhou Summit, the FSB will report its findings on the role of incentives in preventing misconduct, and progress in addressing issues in fixed income, currency and commodity markets. Correspondent banking We are establishing a coordination group, chaired by Alexander Karrer of the Swiss Ministry of Finance, to implement the four-point action plan sent to the Antalya Summit on further steps to assess and address the decline in correspondent banking: (i) Further examining the dimensions and implications of the issue, through collection of additional information; 3 (ii) Clarifying regulatory expectations to give additional certainty and confidence to those engaged in correspondent banking; (iii) Domestic capacity-building to strengthen customer due diligence and other AML/CFT controls in jurisdictions that are home to affected respondent banks, and the sharing of best practices within the financial industry; and (iv) Strengthening tools for customer due diligence by correspondent and respondent banks. • By the Hangzhou Summit, the FSB will report on progress on its correspondent banking action plan. Disclosure task force on climate-related risks Access to better quality information on climate-related financial risks will allow market participants to better understand and manage these risks. The FSB